Janet Yellen and A “True Shift” In Fed Policy

In the January 20, 2014 issue of Time (magazine), Rana Foroohar shares details of an interview with Janet Yellen, the soon-to-be new chair of the Board of Governors of the Federal Reserve System. The article includes several tidbits worth discussing. I would like to focus on the following:

“’I’d like to see real wages going up,’ Yellen says, adding that the average American male worker’s inflation-adjusted wages have been flat or down for the past 20 years . . . Those words may not sound uncommon, but in an institution where people often speak in algorithms rather than English and live in a statistical bubble, Yellen’s focus on the human impact of economics is a true shift. Central bankers have, as she puts it, ‘an important role in public policy and a moral responsibility to take part in it.’ The job, as she sees it, ‘isn’t just about fighting inflation or monitoring the financial system. It’s about trying to help ordinary households get back on their feet and about creating a labor market where people can feel secure and work and get ahead.’”

First, regarding Yellen’s wanting to see real wages going up. If this is the case, it would be wise to lighten up on the “Ctrl+P” function, as the push for higher inflation via money printing will only make the quest for real-wage growth more difficult. As Yellen notes in the Time interview, “Our policy is aimed at holding down long-term interest rates, which supports the recovery by encouraging spending . . . And part of the [economic stimulus] comes through higher house and stock prices, which causes people with homes and stocks to spend more, which causes jobs to be created throughout the economy and income to go up throughout the economy.”

The recovery in the economy has been pushed along by influencing asset prices in hope that it would lead to the outcome Yellen noted in the aforementioned quote. The Fed has long attempted to influence economic outcomes by influencing asset prices. But we have now reached the point at which the labor market is not creating enough full-time, well-paying jobs to handle even the influx of college graduates, let alone the underemployed. Additionally, companies, for several years now, have had a laser-like focus on cutting costs, buying back stock, and growing dividends. This truth may make some uncomfortable to hear, but an incredibly large percentage of public companies pledge their allegiance first to shareholders, not to employees. Because of structural issues in the labor market and cultural issues among public corporations, sustainable real-wage growth will be hard to come by with inflation below the Fed’s 2% target, let alone at or above the Fed’s target. Janet Yellen’s hope for real wages going up has a low likelihood of long-term success if money printing remains the foundation for generating economic growth. Money printing will simply continue the cycle of asset bubbles, which will contribute to companies being even more reluctant to consistently offer generous raises across the board.

Second, it is noble that Janet Yellen feels a “moral responsibility” to take part in public policy and trying to help people get back on their feet and “get ahead.” Whether the Federal Reserve is the appropriate institution to fight those battles is certainly debatable. But if this is Yellen’s belief, and she is the next chair of the Board of Governors of the Federal Reserve System (as she is), then investors will need to adapt to a Fed that, as Yellen views it, “isn’t just about fighting inflation or monitoring the financial system.” Given what I see as the true potential for the U.S. and global economy, absent the Fed’s money printing operation, combined with Yellen’s comments, noted above, I think the Fed is now more likely than ever to remain on hold for longer than most investors think. Remember that ending QE does not mean a rate-hike cycle is imminent. In order to achieve the societal outcomes implied in the Time article, Yellen will likely end up an advocate of the Fed’s zero-interest-rate policy (ZIRP) for many years to come. But one question I would ask her is, “If five years of ultra-easy money haven’t created the conditions the Fed and Yellen desire, what makes people think a few more years of trying the same thing will?”